Harsh Penalties Lurk Behind 2-Tier Annuities

Q: What are the differences between one-tier and two-tier tax-deferred annuities? I am getting conflicting opinions. My friend says the two-tier annuity I bought is a rip-off and I should sell it immediately, even if I have to take a loss. My salesman says my two-tier annuity offers me a higher rate of return. Whom should I believe? --N. P. W.

A: Both your friend and your salesman. Both are telling a version of the truth.

Many financial planners believe that your friend’s assessment is essentially correct: Two-tier annuities can be consumer rip-offs, and, possibly, you were unwise to purchase one. (Whether you should get out of your contract now, however, is another question which we’ll deal with later.) But none of this means that what your salesman said is wrong. He told you the truth--or at least a portion of it. Two-tier annuities usually offer a higher interest rate than single-tier plans. But they also offer a second interest rate--and that one is usually lower than those for single-tier plans.

So what are these two types of plans, and why are they different?


First, remember that an annuity is a financial contract that pays its beneficiary--usually upon retirement--either in monthly, annual or lump-sum installments. Upon their purchase, annuities earn interest, and, when added to your principal payment, form the basis of what you are repaid over the life of the contract.

Interest rates vary from one annuity to another. They also vary depending on the type of payment you elect to receive: a single lump sum or monthly installments. The difference between single- and dual-tier annuity plans comes down to the interest rates each plan offers for the different methods of payment.

A single-tier annuity offers just one interest-rate formula. Your money will earn at this rate regardless of whether you withdraw it as a single lump sum at the end of the contract or in periodic payments. If you don’t know how you will want to take your money when you buy your contract or you change your mind after a few years--as happens with many consumers--it doesn’t matter. You are not penalized. But this single rate is usually lower than the higher of the two rates offered in the two-tier plans.

The latter offer one rate for contract holders who want to withdraw their funds in a single sum at the contract’s expiration, and another for those who want to take their money monthly. The rate is lower for those who elect the lump-sum distribution, usually by at least two percentage points. Depending on the contract, most lump-sum rates are significantly lower than rates of single-tier plans. Consumers who elect the installment plan when they purchase the contract and later change their minds are penalized. Their funds are assigned the lower of the two rates.

Why should there be this disparity?

Insurance companies offering these contracts argue that they should reward policyholders who stay with them, rather than taking their money and running the day the contract expires.

In reality, however, insurance companies make more money on installment payment contracts, since many become null and void upon the death of the primary or joint beneficiary. Whatever isn’t disbursed is kept by the insurance company. Of course, they want to sell the installment plan program, so they offer a sweetener: higher interest rates.

Further--and this you must know--insurance salesmen usually earn higher commissions for selling two-tier contracts than they do for single-tier plans. So, as you might expect, insurance salesmen are given to singing their praises and glossing over their defects.


Now we return to your dilemma: Should you sell your contract? Have a qualified accountant or financial planner assess your contract, the penalties you face for breaking it and your likely alternative investment strategies. If you are planning to take installment payments when the annuity matures and live long enough to get all that is due you, then perhaps this contract was not an unwise investment.

Upon researching your two-tier contract, however, you may discover that its current interest rate is lower than the introductory one. This happens with many annuity contracts. With a single-tier annuity, you could withdraw your money and look for an alternative investment with only minimal penalties. With a two-tier contract, you face a double penalty: a reassignment to the lower lump-sum interest rate, plus the early withdrawal penalty.

Losing Out With a Second Trust Deed

Q: A few years ago, I purchased a second trust deed as an investment. The borrower later filed for bankruptcy and I lost my entire investment. If the borrower is now solvent, is there anything I can do to recover my loss? --E. L. T .


A: Probably not. According to our legal experts, if the borrower’s property was foreclosed on, the lien extinguished and the borrower’s debt discharged, you are out of luck. Of course, you should check the terms of the bankruptcy disposition to be certain, but if the borrower’s legal and financial obligations have been dismissed through the bankruptcy procedure, then you no longer have any claim on the assets of the borrower.

Carla Lazzareschi cannot answer mail individually but will respond in this column to financial questions of general interest. Please do not telephone. Write to Money Talk, Business Section, Los Angeles Times, Times Mirror Square, Los Angeles, Calif. 90053.